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Implementing Responsible Investment
A United Nations Investor Roundtable
Paris, June 16, 2004
Groupama Asset Management, Paris, France
Implementing Responsible Investment
A United Nations Investor Roundtable, June 16, 2004
Groupama Asset Management, Paris, France
Editor: James Gifford
UNEP Finance Initiative, July 2004
© 2004 UNEP Finance Initiative
Implementing Responsible Investments
Extra-financial analysis and investment processes
Materiality of social and environmental risk in oil and gas
Environmental and social issues for the global insurance sector
Responsible investment and fixed income portfolio management
Shareholder engagement: does it make a difference? What are the financial impacts?...... 14 Shareholder Engagement: Morley’s Engagement Processes
Shareholder Engagement: Investor Perspective
Responsible investment in emerging markets
Emerging Markets: Investor Perspective
Constructing an Emerging Markets Portfolio
1 Executive Summary On June 16, the Asset Management Working Group of UNEP Finance Initiative held an Investor Roundtable ‘Implementing Responsible Investment’ in Paris, hosted by Groupama Asset Management. The 40 participants included pension funds from across Europe, consultants, analysts and representatives from the member firms of the Working Group. The
key points that were realised from the meeting included:
Environmental, social and corporate governance issues are clearly material – especially over the long term – and companies and their investors who do not take these issues into account do so at their own peril.
These issues must be brought into the mainstream and firmly integrated into the work of all players, whether they be investors, fund managers, brokers, investment consultants or companies themselves.
Collaboration by investors in their shareholder engagement activities is essential to achieve improvements in corporate behaviour in order to address the risks and opportunities posed by environmental, social and corporate governance issues. There is a clear need for a global alliance of investors to collaborate across borders to bring about this change.
Research, education and the upgrading of skills to address these issues is required on a global basis. There is significant experience with engagement processes in a small number of countries, and this experience can form the basis of a global collaboration.
There are significant opportunities involved in responsible investment in emerging markets, but more research, better information and regulatory frameworks are required to minimise the risks.
Please note: this report should be read in conjunction with the slide shows that were used during the presentations.
They can be downloaded from http://www.unepfi.net/pensions
Introduction CARLOS JOLY, Co-Chair, Asset Management Working Group;
Storebrand At the ExxonMobil AGM on May 26th, a revealing exchange took place between Lee Raymond, ExxonMobil chairman and CEO, and Dale McCormick, the Treasurer of Maine.
When Mr. McCormick asked a question about how the company accounts for liabilities related to climate change regulations on its balance sheet, Mr. Raymond replied: ‘The potential liabilities of climate change are neither likely nor can they be estimated’.
Those of us in asset management who are members of the UNEP FI believe that Raymond is wrong to be dismissive and McCormick is right to ask the question. Climate change risks, other environmental risks, social risks, workplace risks and relations with society do count and are increasingly becoming reflected in equity pricing. The decisions of institutional investment managers like us make that so.
The question is not if environmental, social and corporate governance considerations (ESG) are material but rather when, under what conditions, by how much, the timing and what the appropriate corporate response should be.
In the UNEP FI Asset Management Working Group, we are 12 asset management companies with diverse ways of incorporating ESG into portfolio composition, into engagement with companies and into fundamental company analysis.
There are a number of serious issues relating to ESG:
Excessive claims as to effectiveness of the approach from SRI activists.
Risks and opportunities are exaggerated.
If the ESG company ranking was sufficiently predictive of equity performance, we would not require fundamental company analysis. In fact, ESG is a way of enriching, adding insight and perspective to traditional equity analysis and a way of increasing the confidence or forcing questions about its conclusions. It is no substitute.
One thing we have all felt lacking is sufficiently robust analytic insight into ESG matters from our broker analysts. Hence, a year ago we established a project to invite our brokers to conduct specific research to be shared with the public.
We suggested issues that we thought were relevant but left it up to the brokers to decide on the particular criteria of relevance in their sector.
We reviewed, summarised and interpreted the findings.
We are organised collegially, and work through monthly conference calls, yearly gatherings, emails and phone calls.
We have the support of a capable, professional secretariat.
Extra-financial analysis and investment processes Eric Borremans, Head of SD Research, BNP Paribas Asset Management The slides for this presentation can be found at http://unepfi.net/pensions
Extra-financial criteria for the automotive industry Corporate governance The role of family/state shareholders.
Fuel economy Smog, CO2 and particulate emission standards are becoming more stringent. Some manufacturers are well ahead and some well behind – this will have a financial impact.
New technologies (hybrids, fuel cells) There are big differences between manufacturers in terms of research and development, prototypes and commercialisation.
End-of-life vehicles Manufacturers are currently required to set up recycling infrastructure in all EU member states. This requires investment – some are making provisions, others are not.
Work time flexibility To what extent does the car manufacturer have the ability to accommodate peaks and troughs in production rather than laying off people, causing disruption and losing corporate knowledge?
Pension liabilities For example, for the US car manufacturers.
Employment practices in the supply chain Manufacturers have thousands of suppliers in various regions and there are reputational 5 Implementing Responsible Investment, June 2004, Paris issues associated with the way employment practices are managed within the supply chain.
Why would we see those issues become more relevant to investment decisions?
Well-governed companies tend to outperform poorly governed companies, a trend exacerbated by financial scandals.
More stringent legislation such as CO2 trading schemes.
Changing consumer preferences.
Increasing NGO pressure.
Extra-financial analysis is not meant to be a substitute for financial analysis – it is meant to provide a more complete view of investment risks and opportunities.
Building extra-financial analysis into investment processes The danger with traditional SRI screening is that it not only restricts the fund manager but it also brings with it an inherent conflict of interest between SRI researchers who want to keep stocks out and the fund manager who wants to bring them back in.
Ultimately, we will achieve the systematic integration of environmental, social and governance issues into fundamental analysis. This could be implemented by incorporating a risk premium into the growth rate or cash flow when the materiality of the issue in question becomes clear – e.g., when stringent regulation or CO2 emission allowances are introduced.
However, the full integration of these issues into financial models may be going too far too fast. Company valuation models are very sensitive. Modifying the growth rate or risk premium by a few basis points may lead to large differences in valuation.
At this stage, we decided it was best to run the environmental, social and governance analyses and the financial analyses in parallel. This allows us to get to know the issues and the companies better and build internal capacity and knowledge.
Acceptance of these issues by financial analysts who do not feel confident with these issues because they are not easily quantifiable;
Access time with companies: one-hour meetings are not sufficient to discuss questions of extra-financial issues. Extra time, however, is very beneficial because it enables financial and extra-financial analysts to see each other’s points of view.
Materiality of social and environmental risk in oil and gas Anthony Ling, Co-Director of European Research, Goldman Sachs Anthony Ling’s presentation is based on the Goldman Sachs report, Introducing the Goldman Sachs Energy Environmental and Social Index, which can be found at http://www.unepfi.net/stocks/ The slides for this presentation can be found at http://www.unepfi.net/pensions/ There is really is a tremendous degree of interest in this report not just within the investment community but also within the corporate world. Many companies, however, are still struggling to understand what the investment community wants from them.
BP is the stand out leader, both in terms of their reporting and their management relative to the rest of the industry.
Exxon also does well. American companies perform very badly on climate change but they are relatively outstanding on management diversity, operational excellence etc.
There is a proliferation of second-tier European players Statoil, Norsk Hydro, British Gas, Total – all of them performing significantly better than their US peers.
One-off events or NGO-led campaigns have little impact on share prices other than in the very short term.
The production mix itself is changing from OECD to nonOECD countries. Operating in non-OECD and developing countries is an absolute must for these companies if they are going to succeed.
Projects are getting bigger. The scale of everything has gone up dramatically.
The industry is facing a resourcing crisis. The number of people employed in the US oil industry fell by 30% between 1980 and 1999. The number of people employed in upstream operations has halved over that period. The average age of an upstream employee is now 45. It is extremely difficult to attract new people into the industry. We are asking for more from a reduced workforce and in a more competitive environment.
It is a more transparent industry. Many developing countries want to improve their performance. They are signing up to transparency initiatives. NGOs are having an effect, operating either on their own or together with SRI funds to raise issues, be it Nigeria or pipelines through Azerbaijan and Turkey. The industry cannot ignore these issues.
Environmental awareness is increasing. When you go to do business in a non-OECD country such as Kazakhstan or West Africa, companies cannot get away with poor environmental practice the way that they used to.
An understanding of climate change and its impact on the growth of the gas and renewables industries is essential for success.
Companies like BP and Shell are looking forward 15–20 years. They understand that if the gas industry globalises, it will have a fundamental impact on the structure of the energy industry.
It is the absence of US companies in the index that says something about the success factor of the issues we have outlined today. These leading European companies are managed in a much more sophisticated way. They have the same capital bases as the US companies, and the same technology, maybe less. It is in the way that they are managed that has helped them produce outstanding results, not just now but also in the foreseeable future.
Relative to Exxon, the leading European companies have significantly outperformed.
However, Exxon is changing. They have gone from being nowhere in the gas industry to second behind Shell and on a parallel with BP in terms of exposure to next generation gas assets. If you look at issues other than climate change such as diversity of workforce, number of females employed, safety track record, R&D, investment in the environment, you see a very different Exxon. One glaring area of omission was on climate change and gas, and there is no doubt in our opinion that they have worked that out and that they are a changing if not an already changed entity.
Revealing the ultimate truth about company behaviour is almost impossible, especially in countries like Nigeria. How can you penetrate from the outside to really find out what is going on?
The buy-side community must increase the amount of important it places on these issues in broker polls. Analysts are unlikely to research these issues without being rewarded.
Environmental and social issues for the global insurance sector Volker Kudszus, Associate Director, Insurance Research Analyst, West LB Equity Markets This presentation was based on the West LB report Insurance and Sustainability: Playing with Fire, which can be found at: http://www.unepfi.net/stocks/ The slides for this presentation can be found at http://www.unepfi.net/pensions/
After conducting this study, it was clear that there are many links between insurance, climate change, gene tech and geopolitical risk.
Climate change related claims double every decade. We found the biggest impact is business interruption. The reason most insurers do not care about this if they know that the claims are rising is that most of the business is short-tail business. They can therefore adjust their premiums every year.